Stock Market Liquidity, Aggregate Analyst Forecast Errors, and the Economy

44 Pages Posted: 17 Jan 2013

See all articles by Ji-Chai Lin

Ji-Chai Lin

Hong Kong PolyU

Kenneth John Reichelt

Louisiana State University, Baton Rouge - Department of Accounting

Ping-Wen Sun

Minjiang University - Newhuadu Business School

Date Written: January 4, 2013

Abstract

Næs, Skjeltorp, and Ødegaard (2011) suggest that stock market liquidity is a good leading indicator of the economy because of the “flight-to-quality” behavior of informed investors, whose sells (buys) tend to lead stock market liquidity to decrease (increase) and tend to occur before economic downturns (expansions). To further understand the mechanism in the economic forecastability of stock market liquidity, we hypothesize that analyst earnings forecast errors have a systematic component, which is predictable and related to changes in the economy, and that smart investors exploit analyst forecast errors, which leads to the economic forecastability of stock market liquidity. Consistent with our hypothesis, we find that there is a strong correlation between detrended aggregate analyst forecast errors and concurrent GDP growth and that a large part of the forecast errors can be predicted using lagged macro variables. Once we control for the predictable forecast errors, the economic forecastability of stock market liquidity disappears. Thus, our study reveals that aggregate analyst forecast errors are very informative about business cycle and contain all the relevant information for stock market liquidity as a leading economic indicator.

Keywords: aggregate analyst earnings forecast errors, business cycle, stock market liquidity

JEL Classification: E32, G12, G17

Suggested Citation

Lin, Ji-Chai and Reichelt, Kenneth John and Sun, Ping-Wen, Stock Market Liquidity, Aggregate Analyst Forecast Errors, and the Economy (January 4, 2013). Asian Finance Association (AsFA) 2013 Conference, Available at SSRN: https://ssrn.com/abstract=2201951 or http://dx.doi.org/10.2139/ssrn.2201951

Ji-Chai Lin

Hong Kong PolyU ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon
China

Kenneth John Reichelt

Louisiana State University, Baton Rouge - Department of Accounting ( email )

2821 Business Education Complex
Baton Rouge, LA 70803
United States
225-578-6233 (Phone)

Ping-Wen Sun (Contact Author)

Minjiang University - Newhuadu Business School ( email )

Fujian
China

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